UK: Your new crypto base?

Crypto companies and exchanges are facing unprecedented pressure from financial regulators around the world, with many digital asset businesses starting to consider moving to friendlier locations. This article is part of a series discussing the key considerations of relocating, as well as comparing the appeal of a number of alternative locations. View the Series

In the world of crypto, 2023 has been characterised by increased regulatory scrutiny of the USA's cryptoasset sector. Most notably, the recent enforcement action from the Securities and Exchange Commission on crypto exchanges and cryptoasset businesses has caused considerable concern across the crypto landscape. 

These actions have seen key players look to other markets, including the UK, as an alternative to the USA as a base for operations. Top VC cryptocurrency investor Andreessen Horowitz (aka a16z) is leading this movement, with a16z's first international office opening in London later in 2023, and a crypto startup accelerator programme due to commence in the UK in spring 2024.

FCA financial promotion rules for cryptoassets

The FCA's financial promotion rules² for cryptoassets, which will take effect from 8 October 2023, represent wholesale requirements that businesses will need to comply with in order to promote qualifying cryptoassets to UK consumers. 

What is a financial promotion?

Financial promotion is defined broadly and widely, and includes essentially all forms of communication to consumers, including online advertising, websites, mobile apps and social media posts. 

These financial promotion rules have extraterritorial effect, meaning that all UK firms, and overseas firms, marketing qualifying cryptoassets to UK consumers (including if the marketing is to both UK and non-UK consumers), will need to comply.

What is a qualifying cryptoasset?

In broad terms, qualifying cryptoassets are a "cryptographically secured digital representation of value or contractual rights that are transferable and fungible". This definition would include fungible exchange tokens, such as BTC or ETH. Electronic money, or cryptoassets which are otherwise already caught within the perimeter of the FCA's existing regime, are excluded. 

NFTs would usually be excluded (unless the NFT has fractionalisation features that would cause it to become fungible), along with cryptoassets that can be used within a limited network. However certain tokens that are used to promote NFTs, and which can be purchased using cryptocurrency for subsequent exchange into NFTs, may be caught within the regime, where such assets are fungible. 

Routes for legal cryptoasset promotion to UK consumers

1. Promotion is communicated by a cryptoasset business who is authorised by the FCA (an "authorised person"), where such authorisation is not only under the EMRs or PSRs. 
2. Promotion has been approved by an authorised person, where the cryptoasset business itself is not authorised by the FCA
3. Promotion is made by a cryptoasset business registered with the FCA under the MLRs.
4. Promotion falls within an FPO exemption.

To newcomers to the UK market, Route 2 may look the most appealing (as it does not require direct FCA registration/authorisation) however the process for an authorised person to become registered with the FCA to approve financial promotions is very complex, with practical steps relating to the new financial promotions approval gateway (and the relevant criteria an authorised person would need to meet) still being developed. 

Penalties for non-compliance

The FCA's financial promotion rules have considerable teeth: financial promotions of cryptoassets to UK consumers outside of the above routes are a criminal offence³, punishable by up to two years' imprisonment and/or an unlimited fine.  

FCA "Travel Rule" reporting requirements

The FCA has introduced⁴ strict KYC measures which, from 1 September 2023, require cryptoasset businesses to collect, verify and share information about the sender and recipient of cryptoasset transfers, known as the "Travel Rule", as a measure to help prevent cryptoasset transfers being used as part of criminal activities. 

The Travel Rule requirements apply to any transfers made to another jurisdiction that has implemented the Travel Rule, and are far-reaching, applying when third party suppliers are used. 

Cryptoasset businesses are also responsible for certain additional reporting steps in respect of cryptoasset transfers to and from jurisdictions that have not implemented the Travel Rule.

Transfers to jurisdictions without the Travel Rule

• Take all reasonable steps to attempt to receive information which would be required if the Travel Rule was in effect.
• If such information cannot be received, information required under MLRs is still required to be collected, verified and stored before the cryptoasset transfer is made.

Transfers from jurisdictions without the Travel Rule

• Cryptoasset business must make a risk-based assessment of whether to make the cryptoassets available to the beneficiary, having consideration to whether the transfer contains missing or incomplete information.

Existing AML registration requirements

Since January 2020, which is a long time in the cryptocurrency world, cryptoasset businesses wanting to offer certain cryptoasset services, such as: cryptoassets exchanges, making arrangements for the exchange of cryptoassets or safeguarding of cryptoassets, have been required to register with the FCA under the MLRs for the purposes of anti-money laundering supervision. 

This requirements for registration are tough with, as of 1 September 2023, only 43 of the 324 applications received by the FCA being approved⁵ (13.3% of applications). However there is considerable incentive for a cryptoasset business receiving approval and becoming registered under the MLRs, as Route 3 of the financial promotion rules becomes open for the promotion of cryptoassets to UK consumers, as noted above. 

Treasury Committee position on gambling regulation

In May 2023 this year the Treasury Committee (a cross-party group of MPs who examine matters relating to the policy of the UK Government's Treasury) published a report calling for cryptocurrency trading (trading in unbacked cryptoassets, which are unsupported by any underlying asset) to be regulated by the Gambling Commission, the UK gambling regulator. The rationale for this was the extreme price volatility of cryptocurrency markets; the Committee said such volatility made cryptocurrency trading closer to gambling than a conventional financial service, and cautioned that regulating cryptocurrencies as financial services risked giving consumer an unrealistic sense of confidence in a price-volatile market, which could lead to consumers suffering heavy trading losses. 

The UK Government rejected⁶ this recommendation in July 2023, stating that regulation as a financial service is important to foster a safe environment for innovation in the cryptoasset space, and that this approach is consistent with the approach being adopted in jurisdictions across the world, and with the timing of this rejection broadly coinciding with the publication of the upcoming new FCA requirements, as outlined above. 

Given that the proceeds of gambling are not taxed in the UK, the Government's position is also consistent with HMRC's treatment of cryptoassets as assets capable of being subject to tax.

Other tax and legal considerations

The UK is a relatively high tax jurisdiction. However, businesses looking for as much certainty as possible in the tax treatment of cryptoassets will find a relatively clear approach in the UK (although, as with most other jurisdictions, there remain some grey areas). While there is currently no UK tax legislation dealing specifically with cryptoassets, and no reported tax cases, HMRC has published a lengthy manual7 which it updates periodically, covering its views on the taxation of all manner of crypto transactions, for both individuals and businesses. In the majority of cases, HMRC considers that cryptoassets can be taxed in line with existing tax rules. Notably, however, the government recently consulted on the potential introduction of a bespoke legislative regime for the taxation of Decentralised Finance, with the aim of placing the UK "at the forefront of safe, sustainable and rapid innovation in cryptoasset and blockchain technologies".⁸

Finally, the Law Commission of England and Wales published a report in June 2023 examining fundamental questions of English law that arise as a result of the use and development of cryptoassets (and other digital assets).⁹ The report is an enormous contribution to this developing area of law and provides a deep foundation for the use of English law and English courts in commercial dealings. 

Looking ahead

The UK has some of the strictest cryptoasset business regulatory requirements in the world. It remains to be seen whether the UK Government's commitment to supporting innovation in the cryptoasset space, and the huge potential the UK retail market represents to cryptoasset businesses, will continue to attract more business and investment in a competitive global market.

For advice on FCA regulatory or other cryptoasset business compliance matters, or if you have any questions on this topic, please get in touch with your usual Withers contact or the authors of this article.